Protecting Business LLC Interests in a Personal Chapter 7 Bankruptcy

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Business owners in the Tampa Bay area often file for Chapter 7 bankruptcy. In some cases, those business owners have a sole proprietorship, which is a type of business in which company and personal financial assets are linked. In other words, the business is directly tied to the individual, and the individual’s personal debts are connected to his or her business debts. Yet the situation is much different when an individual who is a member of a limited liability company (LLC) decides to file for personal Chapter 7 bankruptcy. That business owner—as well as other members of the LLC—often has many questions about the financial health of the company when one person files for liquidation bankruptcy. For instance, does the business have to close because one of the members is seeking bankruptcy protection? Will the debtor lose all of his or her interests in the business because she has decided to file for consumer bankruptcy?

The key piece of information to keep in mind is that, as long as an LLC is structured in such a way that it can handle one member’s personal bankruptcy, the business will not necessarily have to close. We will tell you more about how to protect business LLC interests in a personal Chapter 7 bankruptcy.

What is an LLC and How Does it Work? 

To understand how to protect business LLC interests in a consumer bankruptcy, it is important to have a clear understanding of this type of business. As the U.S. Small Business Administration (SBA) explains, a limited liability company has the benefits of a corporation and a partnership. Generally speaking, it is the least complex type of business structure after a sole proprietorship or a partnership. Its structure has some of the benefits of both a partnership and a corporation. The following are some of the key elements of an LLC:

  • – Protection from personal liability if the LLC faces business bankruptcy or a lawsuit;
  • – Pass-through taxes, meaning that the LLC does not have to pay corporate taxes, and instead the owners of the business (known as members) pay taxes on their personal income tax returns;
  • – Lower tax rate than an S corp or a C corp; and
  • – Can be formed with agreements in place to buy, sell, or transfer ownership in the event that one of the members needs or wants to leave the company.

Members have both a management interest and a financial interest in the company.

How to Protect LLC Interests When a Member Files for Consumer Bankruptcy 

What happens to the LLC when one of the members files for consumer bankruptcy? When the LLC is formed, it is important to have an operating agreement that outlines what will happen to the LLC if one of the members files for Chapter 7 bankruptcy. The operating agreement should be set up to protect the LLC in the event of individual bankruptcy.

Most operating agreements make clear that the LLC does not have to be dissolved, but instead the dividends (the member’s financial interest) that would have been distributed to the bankruptcy member either can be:

  • – Claimed by creditors in the bankruptcy case; or
  • – Purchased by the other members of the LLC, with the purchase amount going to the bankruptcy estate.

The member who files for bankruptcy typically cannot protect his or her interest in the LLC. The operating agreement should clarify how the member can leave the company in such a way (as discussed above) that the interests of the other members can remain protected. The debtor’s interest in the business is treated like most other assets that are subject to liquidation in order to repay creditors. 

Contact a Tampa Bankruptcy Lawyer Today 

U.S. bankruptcy law is complex, and consumer bankruptcies are made even more complicated when the individual filing for bankruptcy is also a business owner. If you need help with your bankruptcy case or want to learn more about protecting business LLC interests in a personal Chapter 7 bankruptcy, a dedicated Tampa bankruptcy attorney can speak with you today. Contact Tampa Law Advocates. P.A. to learn more about how we can help with your case.

Resource:

sba.gov/business-guide/launch-your-business/choose-business-structure